Credit for Increasing Research Activities – IRC §41

By Lino Pereira

The Protecting Americans from Tax Hikes Act of 2015 made three significant changes to Research and Development Credit:

• The R&D Credit has been made permanent, with retroactive effect.
• Eligible small businesses will be able to claim the R&D Credit against both regular income tax and Alternative Minimum Tax now.
• A qualified small business will be able to claim a portion of credit against Payroll taxes:
  • The maximum credit allowed is $250,000 per year for up to five years; and
  • A qualified small business includes a corporation or a partnership with –
    • Gross receipts less than $5 million during taxable year, and
    • Gross receipts for five years or less. A company is not eligible if it generated gross receipts prior to 2012.

There is no requirement that the taxpayer had to be in existence during the entire five-year testing period.

The payroll tax credit portion is allowed only against the employer’s portion of social security libaility – 6.2% wages subject to the tax. The credit is not allowed against the employer’s portion of the 1.45% Medicare tax, income tax withheld, or the employer’s FUTA.

Making the Election to reduce Payroll Taxes

The election to claim the portion of the R&D Credit against payroll taxes must be made on a timely filed (including extensions) tax return for the entity or individual. The election must include the amount of credit which the taxpayer elects to have applied to employment taxes and may be revoked only with the consent of the Internal Revenue Service (IRS). The amount of R&D Credit that the taxpayer elects to have applied against employment taxes is termed the “payroll tax credit portion” under IRC §41(h)(2).

The election is made by checking the box on line 41 in next Section D of Form 6765, Credit for Increasing Research Activities.

Effective Date

The payroll tax credit portion will be allowed on an employment tax return for the first calendar quarter which begins after the date on which the taxpayer files their income tax return on which the election is made. Any excess credit is carried forward and applied to the payroll tax liability in succeeding quarters until the entire credit is used up.

Thus, if a calendar year corporation files their income tax return on March 15 which includes a claim for the payroll credit, they will get the credit beginning with the second calendar quarter. If they file on July 22, they will not be able to get any credit until the fourth calendar quarter.

How to claim against Payroll taxes

Credit reporting will follow this path:

• Form 6765, Credit for increasing Research Activities: There is a new Section D in which the taxpayer checks a box to make the election and elects the amount of credit to be applied as a payroll tax credit;
• Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities: This is the “bridge form” between Form 6765 and Form 941. It calculates the amount of the payroll credit that will be carried to Form 941. It gets attached to Form 941; and
• Form 941, Employer’s Quarterly Federal Tax Return: A new line is added that takes credit for the payroll tax credit. The amount comes from Form 8974.

Any amount of payroll tax credit portion not used on an employment tax return will be carried forward to the succeeding quarter.

No Carrybacks or carryforwards from pre-PATH Act years

A taxpayer cannot carry back Research Credits to offset payroll taxes in taxable years beginning before January 1, 2016. Carryforward credits from taxable years beginning before January 1, 2016 cannot be used to offset payroll taxes.